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Stock Valuation with P/E and P/B Ratios

The document discusses stock valuation using multiples, a method that estimates a stock's value by comparing it to similar companies through financial ratios like P/E, P/B, and P/S. It highlights the limitations of dividend-based models, particularly for growth and technology firms, and provides examples of how to calculate intrinsic values using the P/E and P/B ratios for Orion Technologies and NovaBank Group. The document includes specific calculations and comparisons to determine if stocks are overvalued, undervalued, or fairly valued.

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14 views2 pages

Stock Valuation with P/E and P/B Ratios

The document discusses stock valuation using multiples, a method that estimates a stock's value by comparing it to similar companies through financial ratios like P/E, P/B, and P/S. It highlights the limitations of dividend-based models, particularly for growth and technology firms, and provides examples of how to calculate intrinsic values using the P/E and P/B ratios for Orion Technologies and NovaBank Group. The document includes specific calculations and comparisons to determine if stocks are overvalued, undervalued, or fairly valued.

Uploaded by

abdelrahman.bhamdan
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Stock Valuation Using Multiples

a relative valuation method that estimates a stock’s value by comparing it with similar companies using common financial
ratios such as Price-Earnings (P/E), Price-Book (P/B), or Price-Sales (P/S).

Why Use Valuation Multiples?

A key limitation of dividend-based valuation models is that many companies do not pay dividends, or they have unstable
or unpredictable dividend patterns. This is especially common for:
 Growth firms
 Technology companies
 Young or early-stage firms

In such cases, analysts often rely on valuation multiples, which compare a company’s market value to a key performance
measure such as earnings, sales, or cash flow.

1. Price–Earnings (PE) Ratio Valuation


Definition
Price per share
PE ratio=
Earnings per share (EPS)
Valuation Formula
Pt =(Benchmark PE)× EPSt

Where the benchmark PE can be:

 Industry average or median


 Comparable firms
 The company’s own historical PE

Example:

Orion Technologies is a publicly traded company operating in the consumer electronics industry. The company does not
pay dividends. Therefore, financial analysts value Orion’s shares using a Price–Earnings (P/E) ratio approach.

For the most recent year, Orion reported net income of $124 million. The company has 20 million common shares
outstanding. After analyzing comparable firms in the same industry with similar risk and growth characteristics, analysts
believe that an appropriate benchmark P/E ratio is 18. Orion’s shares are currently trading in the market at $105 per
share.

Required:

1. Compute Orion Technologies’ earnings per share (EPS).


2. Estimate the intrinsic value per share using the P/E ratio valuation method.
3. Compare the estimated intrinsic value with the current market price and determine whether the stock appears to
be overvalued, undervalued, or fairly valued.

1
2. The Price-to-Book (P/B) ratio

compares a company’s market value to the accounting value of its net assets.

Market price per share


P/B ratio=
Book value per share

Where:

Total equity−Preferred equity


Book value per share=
Number of common shares

The valuation formula

Estimated Stock Price=(Benchmark P/B)×(Book Value per Share)

Example:

NovaBank Group is a publicly traded financial institution whose management is interested in assessing whether the
company’s common stock is fairly valued by the market. Because NovaBank’s operations are highly asset-driven and
its balance sheet plays a central role in value creation, financial analysts have decided to use the Price-to-Book (P/B)
ratio valuation approach.

The following information is available:

 Total shareholders’ equity: $4,800,000


 Preferred equity: $800,000
 Number of common shares outstanding: 400,000 shares
 Current market price per share: $14
 Average P/B ratio of comparable financial institutions: 1.6

Required

1. Compute the book value per share of NovaBank’s common stock.


2. Calculate NovaBank’s current P/B ratio based on its market price.
3. Estimate the intrinsic value of NovaBank’s stock using the benchmark P/B ratio.
4. Compare the estimated intrinsic value with the current market price and determine whether the stock appears to
be overvalued, undervalued, or fairly valued.

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